American Depositary Receipts (ADR) Meaning
American Depositary Receipts (ADRs) are the stocks of the foreign companies which are traded in the American markets. ADRs are purchased by the investors in U.S. dollars during the normal trading hours in the U.S. market through the brokers of the U.S. which allows the people of America to invest in foreign companies. The ADR was firstly created in the year 1927 by the J.P. Morgan in which Americans were allowed to invest in Selfridges’s shares which is a British department store.
Presently there are thousands of ADRs available which represents the shares of different companies located in different countries. According to the Securities and Exchange Commission (SEC), it is more convenient for the investors to own ADRs in place of the foreign stock itself because they have protection and transparency in case of ADRs facilitated by the U.S. securities regulation.
Types of American Depositary Receipts (ADRs)
There are two basic types of American depositary receipts which are as follows:
Type #1 – Sponsored ADR
The Sponsored ADRs are issued by the bank on behalf of the foreign company where there exists the legal arrangement between the two parties. In the case of sponsored ADRs transactions with the investors will be handled by the bank while the cost of issuing ADRs and control of ADR will be of foreign company.
The sponsored ADRs are registered with the Securities and Exchange Commission (SEC) (except sponsored ADRs lowest level) and are traded on the major stock exchanges of the U.S.
Type #2 – Unsponsored ADR
Unsponsored ADRs are the shares that are traded on the over-the-counter market (OTC). A bank issues unsponsored ADR according to the demand in the market where the foreign company under consideration has no participation or formal or legal agreement with the depository bank. The unsponsored ADRs are never included for the voting rights.
Example of the American Depositary Receipts (ADRs)
Let’s consider an example of the German company named Volkswagen shares of which trades on the New York Stock Exchange. After the compliance of various laws, it got listed on the American stock exchange. Now, investors in America through the stock exchange can invest in Volkswagen. In case apart from the US market if Volkswagen’s shares are listed in other country’s stock markets as well then it would be termed as the GDR.
Advantages of the American Depositary Receipts
There are several different advantages of the American Depositary providing the opportunity for the international investors and the issuer of the ADRs. Some of the advantages are as follows:
- The issuer of the ADRs can get access to the capital available in the market of the US and get the diversified base of the shareholders (U.S. shareholders).
- ADR makes it easy for the issuer to go for Merger and Acquisition activities as they can use ADR as the currency for the acquisition.
- For the investor, ADRs are easy to use as they can buy and sell the shares of the other countries company like their own countries company. Also, there is no need for a new broker or to open a foreign brokerage account as investors can use the same broker with whom they normally deal.
- An investor gets the opportunity to diversify their investment portfolio on a global scale.
- Everything is done as per the U.S. working. ADRs are purchased by the investors in U.S. dollars, dividends are given in dollars, traded during the normal trading hours in the U.S. and are subject to similar settlement procedures as that of the American stocks.
- This gives more accessibility of research and information to the investors and investors can customize their portfolio according to their requirements like which countries they are interested in or which sector etc.
Disadvantages of the American Depositary Receipts
Limitations and drawbacks of the ADRs include the following:
- The unsponsored ADRs may not be compliant with the Securities and Exchange Commission (SEC)
- The investors might have limited companies for the selection as all the foreign companies are not available as ADRs.
- For the purpose of diversification, an investor needs enough capital investment otherwise it will not be possible to create a properly diversified portfolio.
- The investor might have to face the double taxation in case the dividend is taxed differently as ADRs dividends received may be subject to the tax in the home country of the company.
Important points of the American Depositary Receipts
- Before the investment in ADRs, one should consult with both a tax advisor and the financial advisor in order to understand the implications of the portfolio in which the person is planning to invest its capital. Also as it involves international investing, initially one should go with international mutual fund present until one gets the good knowledge about the same.
- There are several unique differences between American Depositary Receipts and foreign stocks or the traditional U.S. stocks which one should consider before making any investment. Like taxes on the dividend may be charged differently. In the case of the U.S. stocks taxes on the U.S. stock will be charged in the U.S. only whereas in case of ADRs dividends may be subject to the tax in the home country of the company also. In that case, in order to avoid double taxation, investors might have to apply for either refund from a foreign country or apply for credit against their U.S. taxes.
Thus it can be concluded that the American Depositary Receipts (ADRs) provide the opportunity to the investors of the U. S. to trade in the shares of the foreign companies in an easy and convenient manner. American Depositary Receipts also gives the opportunity to the investors for the diversification of its portfolio as they can invest in companies that are not based in their home country America.
With the help of American Depositary Receipts investors invest in the companies which are located in the emerging markets where they can maximize their profit out of the money invested by them. So the American Depositary Receipts remove the restrictions of the Americans of investing only in the home country.
This has been a guide to What is American Depositary Receipts (ADRs) and its meaning? Here the top types of American Depositary Receipts along with examples, advantages, and disadvantages. You can learn more about Investment Banking from the following articles –